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New Benchmarks Crop Up in Companies' Financial Reports

By

Emily Chasan

Updated Nov. 13, 2012 10:28 a.m. ET

Companies are increasingly augmenting their financial reports with nontraditional performance benchmarks that aren't defined by U.S. accounting standards, forcing securities regulators to step up efforts to ensure that investors don't get suspect or misleading information.

The companies that tout these newfangled indicators, such as "paid membership rates," number of "active users" or "cumulative customers," say these figures are essential to understanding their operations. But regulators and investors want to make certain these newer measurements are directly related to company performance.

Steve Dininno

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"We're working really hard to make sure we understand industry practices and the resulting disclosures,"
Shelley Parratt,
deputy director of disclosure operations at the Securities and Exchange Commission's Division of Corporation Finance, said last week at a New York conference.Ms. Parratt told the Practising Law Institute gathering that the agency's goal is to "make sure disclosures are balanced and clearly linked to a company's results."

A major concern is how companies present the new indicators. The SEC asked real-estate company
Prologis Inc.
PLD -0.08%
and retailer
Home Depot Inc.
HD -0.26%
in May to remove certain income tables from their filings because the nonstandard metrics were featured too prominently, exaggerating their importance.

After receiving the SEC's letters, Home Depot and Prologis both agreed to change the way they displayed the information.

The agency also is paying closer attention to the benchmarks provided by companies pursuing initial public offerings, as they try to highlight what they consider to be the unique aspects of their businesses. Some 47% of the biggest 45 venture-backed firms that went public in the U.S. this year have provided operating metrics other than traditional accounting figures, up from 26% a year earlier, according to a study by law firm Wilson Sonsini Goodrich & Rosati

The venture-backed firms also have increased their use of nonstandard measures such as earnings before interest, taxes, depreciation and amortization, or Ebitda, and "free cash flow," with 58% disclosing financial benchmarks that aren't part of generally accepted accounting principles, up from 50% in 2011.

Analysts and investors say the measures can be helpful. But because they are nonstandard, the figures may not allow investors to make comparisons between companies or from year to year.

"There is value to them, but the question is how good are they, how much weight do you give them and how do they change over time?" said
Sandra Peters,
head of financial reporting policy for the CFA Institute, a trade group for financial analysts.

U.S. accounting rules allow companies to use the newer measures as long as they aren't found to be misleading. But they are required to disclose how they stack up to the most directly comparable GAAP number.

Alternative metrics fell out of favor in the aftermath of the dot-com bust more than a decade ago, when unprofitable Internet companies emphasized metrics like "eyeballs," and "mindshare." But the current resurgence is partially the SEC's doing.

The agency noticed companies were discussing nonstandard indicators with analysts and investors at roadshows and conferences, but not fully including them in the financial statements they filed with the SEC. In 2010, the regulator asked companies to include those measures in filings as well.

"Because companies use them and they've shown them to their venture-backed investors, they feel like the public investors are also looking at these measures and want them," said
Richard Blake,
a partner in Wilson Sonsini's Palo Alto, Calif., office.

Some remain suspicious of the alternative metrics because they aren't subject to rigorous accounting rules and aren't audited. The nonstandard benchmarks are something companies "really need to explain," said
Stephen Brown,
senior director of corporate governance at pension-fund manager TIAA-CREF.

Last year, the daily-deal site
Groupon Inc.
GRPN -3.37%
removed a controversial measure known as "adjusted consolidated segment operating income" from its IPO filing, under pressure from the SEC. The measure stripped out all marketing expenses, which are one of Groupon's biggest costs. But the company went public using measurements like "cumulative customers," even after the SEC questioned how it was calculating that statistic. Groupon eventually dropped it and now focuses on slightly more traditional operating metrics such as "active customers."

Groupon declined to comment.

The SEC staff still is reminding companies in speeches not to use nonstandard measures that inappropriately excluded normal cash operating expenses. In September, the regulator asked Internet phone company
Vonage Holdings Corp.
VG -1.40%
to revise a measure called "pre-marketing operating income."

Vonage had used the yardstick since it went public in 2006 to show investors the profitability of its existing client base without the marketing costs associated with recruiting new customers, but it said it told the SEC in September that it would drop the metric from future filings.

The Financial Accounting Standards Board has been looking at whether the increased use of alternative financial measures reflects shortcomings in current accounting standards.

In a review of 140 companies published last month, the U.S. accounting standards setter found that large companies were likely to use adjusted figures for revenue, free cash flow, operating income, operating margin, net income and earnings, while smaller companies tended to focus on adjusting earnings before interest taxes depreciation and amortization figures and free cash flow.